WRITTEN BY: Eversheds Sutherland (US) LLP
On July 2, 2020, the IRS issued proposed1 and temporary regulations2 under section 1502 that implement certain statutory amendments made by the Tax Cuts and Jobs Act3 (TCJA) and Coronavirus Aid, Relief, and Economic Security Act (CARES) Act.4 Generally, the regulation package addresses the absorption of consolidated net operating loss (NOL) carryovers and carrybacks by consolidated groups under the TCJA and CARES Act.
In the transactional context, the regulation package provides a solution to the issue created subsequent to the CARES Act’s taxpayer-favorable NOL carryback provisions that allow consolidated groups that acquired the subsidiary of another consolidated group to elect to waive all or part of the pre-acquisition portion of the extended carryback period for some losses attributable to the acquired members. This regulatory solution provides more flexibility for split-waiver elections so that acquiring groups can decide how NOLs should be applied and enhance their liquidity through efficient use of the enhanced NOL carryback potential. Taxpayers should appreciate this favorable resolution as they contemplate the implementation and effect of the CARES Act NOL provisions on recent transactions.
Prior to the TCJA, section 172(a) allowed taxpayers to use their aggregate NOL carryovers and carrybacks to a taxable year to offset all taxable income in the taxable year. Section 172(b)(1) generally allowed taxpayers to carryback NOLs two years, and carry forward NOLs 20 years.
The TCJA amended section 172 limiting the deduction of a taxpayer’s NOL to 80% of the taxpayer’s taxable income, and eliminated all NOL carrybacks, except for a special two-year carryback for farms and certain nonlife insurance companies. Until the CARES Act was enacted, the limitation would have applied to losses arising in taxable years beginning after December 31, 2017 (post-2017 NOLs). In general, a post-2017 NOL deduction may be carried forward indefinitely.
Seeking to provide relief to companies in light of the economic crisis in connection with the Coronavirus pandemic, Congress enacted the CARES Act, providing, among other taxpayer-favorable provisions, a five-year carryback for NOLs arising in 2018, 2019 and 2020. The CARES Act also eliminated the 80% limitation for taxable years beginning before 2021. The extended five-year carryback provision, however, creates unique issues for consolidated groups, particularly with respect to groups, which have members that joined the consolidated group after being a member of a prior consolidated group during the five-year period.
Proposed and temporary regulations
The proposed regulations address several different issues related to the revisions of the NOL provisions under the TCJA and the CARES Act. Specifically, the regulations provide: (i) guidance for consolidated groups regarding the application of the 80-percent limitation to post-2017 NOLs for taxable years beginning after December 31, 2020; (ii) special rules for consolidated groups that include at least one nonlife insurance company; (iii) special rules applicable to losses incurred by farming businesses; (iv) rules determining the calculation of the limitation to losses from separate return limitation years (SRLYs); and (v) an almost complete rewrite of the Treas. Reg. § 1.1502-47 “life-nonlife regulations” to reflect the current law applicable to insurance companies.
With respect to losses attributable to an acquired member that arose prior to the CARES Act and which occurred while it was part of a different consolidated group, the temporary regulations allow the new consolidated group, to elect to waive all or part of the pre-acquisition portion of the extended carryback period otherwise available under section 172 and arising as a result of the CARES Act. As noted in the preamble to the temporary regulations, changes made by the CARES Act to provide a five-year carryback period for 2018, 2019 and 2020 losses “uniquely impact consolidated groups that acquire one or more corporations prior to the statutory extension of the carryback period.”5 Accordingly, the IRS determined it was appropriate to provide acquiring groups the ability to waive all or a portion of the carryback period with regard to consolidated NOLs attributable to acquired members for pre-acquisition years during which the acquired members were members of a former group. These split-waiver election options are consistent with previous split-waiver election procedures and conditions provided in 2002 and 2010 temporary regulations.
The temporary regulations specifically identify two similar, although slightly different, split-waiver elections available to consolidated groups that have recently completed transactions: the ‘amended statute split-waiver election’ and the ‘extended split-waiver election.’6 While the conditions and procedures for making either election are generally the same, there is a critical difference between them. The amended statute split-waiver election is an irrevocable election made by an acquiring group, on a taxable year by taxable year basis, with respect to any amended carryback CNOL, to relinquish the portion of the carryback period (including the default carryback period and the extended carryback period) for that loss during which an acquired member was a member of any former group. In contrast, the extended split-waiver election provides an irrevocable election only to relinquish the portion of the extended carryback period (and no part of the default carryback period) for that loss during which the acquired member was a member of the former group.
Eversheds Sutherland Observation: Companies that have recently completed transactions should be aware of these renewed split-waiver election options to more efficiently utilize the favorable NOL carryback rules provided in the CARES Act. Without the option to waive some but not all of a consolidated group’s ability to carryback losses, acquiring groups might otherwise have been forced to forgo the liquidity benefit allowed under the CARES Act. Absent this provision, the annual waiver election is an all or nothing proposition. That is, an acquiring consolidated group could make the annual waiver election on behalf of the group for its entire NOL carryback if it hadn’t previously made the one-time split-waiver election for a newly acquired target corporation (for the year in which it acquired the corporation). This election to waive the carrybacks for the entire group comes at the cost of sacrificing other portions of the group’s losses that it could otherwise carry back to its own prior years under the CARES Act.Eversheds Sutherland Observation: Beyond reviewing and utilizing these new regulatory provisions to take advantage of the CARES Act NOL relief, it will also be important for companies to consider a number of other provisions of CARES Act and other recently issued IRS guidance that may have an impact on underlying transactions. For example, the CARES Act provision, which allows employers to defer their share of 2020 payroll taxes to 2021 and 2022, is generally being treated as a deferred liability when exercised by target companies. It will be important for acquiring companies to confirm such treatment to properly value and incorporate target entities into their corporate structures and ensure the favorable NOL provisions provided in the CARES Act are fully utilized. Additionally, companies will also want to understand the treatment and use of the CARES Act technical correction to bonus depreciation for qualified improvement property, as well as a target company’s application of the business interest expense rule changes made by the CARES Act, and the revocation of any previous elections in accordance with the administrative guidance issued under new legislation. Each of these items could potentially impact the amount and availability of NOLs.